Euro Bonds Gain Momentum, With Limits

Skeptics Say They Wouldn't Fix Flaws of Currency Union, and Would Take Time

By

Stephen Fidler

September 16, 2011

For the first time this week, European officials have formally begun to examine the possibility of joining to issue euro-zone bonds to address an ever-worsening financial crisis.

For the first time this week, European officials have formally begun to examine the possibility of joining to issue euro-zone bonds to address an ever-worsening financial crisis. What are the implications? Stephen Fidler discusses. (Photo: AFP / Getty Images.)

Pros and Cons of Issuing Euro Bonds

THE BENEFITS

Combine the financial muscle of the euro zone and ease the debt crisis

Reduce borrowing costs for most members of the euro zone

Make countries less likely to fall prey to market mood swings

Offer competition to the U.S. Treasury market and the dollar as the main reserve currency

THE DRAWBACKS

Delay incentives for action by weak economies

Bloat overall debt and damage credit standing of strong economies

Deepen E.U. divisions because of the bonds' unpopularity

Would need time to implement, at a time when quick action is needed

Such bonds still appear a long way off: Germany and other euro-zone governments worry they would draw them deeper into the crisis. But there is a growing acceptance that joint-bond issues would cut borrowing costs for most members of the 17-nation monetary union, which collectively has lower public debt and lower deficits than the U.S. They could even resolve the euro-zone's debt crisis, or at least provide breathing space to do so.

Provoked by the intensifying crisis, the bonds may have moved closer to reality this week. José Manuel Barroso, president of the European Commission, which proposes European Union legislation, said Wednesday it would soon put forward options for such bonds. That is a long way from actually issuing them, but it will place the idea officially before governments for the first time.

Even proponents, however, admit that euro bonds don't themselves solve the issues of a deeply flawed currency union but merely buy time to address its weaknesses.

Skeptics, including the German government and others, see dangers. German Chancellor Angela Merkel "is actually right," says Charles Goodhart, professor of banking and finance at the London School of Economics. "It doesn't solve anything. It's a massive exercise of kicking the can down the road that could put the better-run countries of the euro zone at risk."

Issuing euro bonds "is putting the cart before the horse," the professor said. "The horse is a degree of fiscal and political centralization."

Experience shows, skeptics say, that once market pressure is lifted—in this case as a result of the issuance of euro bonds—governments of weak economies won't follow through with unpopular actions to inject dynamism into their economies and tighten their budgets. In that case, all euro bonds will have achieved is to bloat the debt of the entire euro zone while addressing none of its structural problems.

Mr. Goodhart points out that the term euro bond is used loosely and could describe many different operations. Questions abound about, among other things, which entity should issue them, whether they would be a temporary salve or a permanent mechanism and how to police the borrowing of governments using the bonds.

And, say backers, there are ways to structure such bonds to keep incentives on weaker economies to shape up.

More

Wim Boonstra, an economist at Rabobank of the Netherlands, said central financing of the euro-zone's budget deficits could be achieved via a central agency. Those states that don't bring budgets into line would be surcharged by the agency—though they would be insulated from more extreme market fluctuations—and other less profligate borrowers wouldn't suffer.

The surcharges would go into a financial reserve to act as insurance against future financing problems. Euro-zone budget rules should be tightened and enforced, Mr. Boonstra said. Entry into the agency of debt-challenged Greece, Portugal and Ireland should be delayed until their debts are under control.

Some officials say, however, that even if the bonds can be structured to offer a technical solution to an economic problem, the outcome risks being unpalatable to European voters.

One European official, speaking on condition he not be named, divides euro-bond supporters into three categories: officials from weak economies who want Germany to get them off the hook; European federalists who may not have thought through the economics but see them as an opportunity to push for closer integration; and banks and other investors who want bad investments paid in full.

That, in his view, would make them a poor solution to the crisis. "Indeed, the European official said, "even if Chancellor Merkel might be won round in extremis, the introduction of euro bonds could prove so politically toxic with voters in many countries that it could irretrievably destroy support for the euro and the European Union."

For now, politicians continue to tread cautiously. Mr. Barroso noted that euro bonds would require treaty changes, adding they "are not going to be a substitute for Greece doing its homework or for euro-area countries strengthening their fiscal surveillance."

Valérie Pécresse, spokeswoman for the French government said this week: "Euro bonds are for us the end of a process of consolidation in the euro zone, because sharing debt also requires the convergence of our budget policies."

It is doubtful then, that if they do happen, euro bonds will come quickly. As demonstrated throughout the crisis, the wheels of European democracy turn more slowly than financial markets demand.

The onus therefore will remain on the European Central Bank. The ECB's reluctant purchases of Italian and Spanish debt are holding the crisis at bay, but even this holding pattern looks unstable as worries about Italy's €1.9 trillion ($2.6 trillion) of public debt raise questions about European banks stuffed to the gills with government bonds.

Barring unexpected good news, then, the only way now to break the crisis cycle is for the ECB to shed its reluctance to act, said Sony Kapoor of Re-Define, a financial think tank. "Decisive and bold action by the ECB entailing an open-ended commitment to do 'whatever it takes' would stem the panic and create space for more growth-friendly policies and a serious discussion on euro bonds," he said.

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